Monday, March 1, 2010

Inventories Don't Kill Growth--People Kill Growth

[UPDATE below.]

This is an esoteric piece, but is actually one of my personal favorites. I was struggling with this notion of an "inventory bump" in GDP growth for a while, and I resolved the issues (at least to my own satisfaction) in this article. So if you have always been vaguely uncomfortable with people attributing percentages of GDP growth to inventory adjustments, this one's for you. From the conclusion:

The textbook GDP equation is not false; it is a tautology and so of course it is true. Nonetheless, it is a destructive framework for thinking about macroeconomic events. Abuse of the equation leads economists and pundits to blame savings and praise reckless consumption, to hate imports and love exports, and (in principle) to attribute a doubling in the flow of goods coming out of factories to a nonchange in the level of a nonexistent stock of inventory.

The part I've just underlined is the contribution of the article; I came up with an easy numerical illustration showing that the standard GDP logic leads to that absurd possibility.

UPDATE: David R. Henderson has a good piece on "GDP fetishism" at EconLib today. Something isn't quite clicking for me in his example of the government paying $10 billion to workers who dig holes and then fill them up. David argues that if the workers get paid $10/hour for work that they would only have been willing to do for at least $6, then only $4 billion of "well-being" has been created on net, once we take into account the loss of leisure. But isn't this too an overstatement, since the workers only value the wages because of the actual goods and services they will be able to buy (and hence redistribute away from everyone else)? Maybe David is capturing that in his categories of price inflation or future tax hikes. Anyway, it's a good article.

The thing I don't get is that, if the absolute GDP figures used to calculate %GDP growth are both post-inventory-change-adjustment, why it even makes sense to talk about the contribution of inventory adjustment to GDP percentage change (given that it is specifically excluded from the both the GDP figure at time t and at time t+1). It's really misleading isn't it?